ETFs aren’t just for passive investing anymore

The next ETFs you might own may be managed by a mutual fund company

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The advantages of ETFs over other investment structures are well documented and yet a large number of Canadian investors continue to be loyal to mutual funds. But what if you could combine the best of both worlds: a low cost structure with an investment manager setting the strategy? A new breed of ETFs streaming into Canada will provide investors just that.

Even though many investors cling to their mutual funds, the traditional mutual fund companies are feeling the pressure of ETFs and are coming up with their own products to ensure they aren’t left behind. So far this year ETFGI, an independent research & consultancy firm specializing in ETFs, reports that there has been a 33% increase in smart-Beta ETFs, or rules-based investments, and a 47% jump in active, or discretionary managed, funds globally. 

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It was only a matter of time before those structures pushed their way north. A steady stream of new active and smart-beta ETFs are coming to Canada this year giving investors more options, not just in the number of choices, but in investment style. At the end of April Manulife launched a new set of ETFs managed by Dimension Financial Advisors, a U.S.-based mutual fund company that uses factor-based models to build portfolios that have a devoted following of advisors.). They are not alone. Franklin Templeton, a global investment management organization that until recently specialized in mutual funds, has been expanding into ETFs in recent years and in a few weeks it will offer four ETFs in Canada.  

More ETFs mean more choice

“Clients are asking about ETFs, and that’s growing globally obviously, and we want to bring that choice to our clients,” says Patrick O’Connor, global head of ETFs for Franklin Templeton Investments. Franklin’s first two offerings will be actively managed ETFs, the Franklin Liberty Risk Managed Canadian Equity ETF and Franklin Liberty Canadian Investment Grade Corporate ETF. Both will start trading on May 30.

In early June, Franklin Templeton will launch a pair of strategic beta ETFs. Franklin LibertyQT U.S. Equity Index ETF and Franklin LibertyQT International Equity Index ETF, are expected to be listed on the TSX at market open on June 5, 2017. Both funds will be rules based. The U.S. Equity fund will follow four custom weighted factors: quality (50%), value (30%), momentum (10%) and low volatility (10%). The portfolio will screen for stocks on Russell 1000 and will rebalance twice a year. No single company will be allowed to exceed 1% of the portfolio. This approach will reduce the large cap bias you see in some funds, says O’Connor. The approach will limit the number of large cap stocks in the portfolio, which typically are high quality but slower growth companies.

Templeton plans to bring even more ETFs to Canada, but it doesn’t have any plans to enter the crowded passive ETF market. “Our DNA is active,” says O’Connor. “That’s not a space we want to play in; it doesn’t speak to who we are.” 

Too much choice?

Investors may welcome the new ETF flavours, but as the saying goes, be careful what you wish for. “It’s exciting for investors, and terrifying for investors,” says Mark Yamada, president and CEO of Pur Investing, which builds ETF portfolios for both individuals and institutional clients.

The new flavours of ETFs are more difficult to digest and the added choice could overwhelm investors. Yamada cites the research of Sheena Iyengar, S. T. Lee professor of business at Columbia University. Iyengar found that while consumers will pay more attention to markets that offer more choice, too many options tends to have a paralyzing effect. The end result is, if there are too many options consumers tend to put off their decision.

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Canada already has almost 500 ETFs, but the new type of product will make the market even more complex. Individual investors are going to find it more difficult to build their portfolio on their own, says Yamada. In the end he says he expects investors may need an advisor to help them make the decision. 

The good news is the new entrants into the ETF market will signal lower fees for Canadian investors, says Yamada. That’s critical. While you’ll never know what your return is going to be, you’ll always know your costs, explains Yamada. 

Competition is keeping costs down

Not only will the added competition in the ETF space help keep costs down, it’s also offering investors alternatives to more expensive mutual funds. The new Templeton funds, for instance, will cost between 0.25 and 0.4%. Franklin Templeton’s mutual funds, by comparison, typically have MERs over 2%.

While the managers who manage Templeton’s new Canadian ETFs also manage mutual funds, the products won’t be the same. “These are not copycat products,” says O’Connor. “There are differences in how they are managed.”

Only time will tell whether the Templeton mutual fund or ETF will perform better over time. Until then, it’s up to you to decide if any of these products are right for you. 

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